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The Charter Company* The Charter Company was organized in 1959 as a consolidation of several existing corporations. The companys primary line of business was petroleum production and marketing, although it also maintained a significant equity investment in the Charter Security Life Insurance Company. In 1983, the Charter Company was listed by Fortune magazine among the 100 largest U.S. industrial companies. For the year ended December 31, 1983, revenues totaled $5.7 billion, and income from continuing operations was $50.4 million. For 1982, revenues were $4 billion, and earnings from continuing operations were $29.8 million. In spite of the continuing worldwide glut in crude oil and petroleum products, Charter had maintained its quarterly dividend of $.25 per share from the second quarter of 1980 through the first quarter of 1984. During 1983 and early 1984, Charters common stock traded in a range of $8.00 to $13.75. In the latter half of 1983, however, a number of adverse articles began appearing in the financial press, questioning the quality of Charters reported earnings. Nonetheless, the companys 1983 financial statements, released in early 1984, indicated no particular financial concerns. Moreover, the firms Big Eight auditing firm, Peat, Marwick, Mitchell & Co., had issued a clean opinion subject only to a consistency qualification (to which they concurred). During the first week of April 1984, however, Charter reported a substantial first quarter loss and announced plans to cut oil production and lay off employees.The companys common stock dropped in price from $9.50 per share on April 3 to $6.625 on April 5. The price then steadily decreased to $3.25 by the end of April. On April 20, 1984, the Charter Company and 43 of its subsidiaries filed voluntary petitions for relief under Chapter 11 of the Bankruptcy Act. Copyright 1988: C. Norgaad and R. Kochanek Questions: 1. Calculate the following ratios for each year during the period 1980-1983. Comment on the trend indicated by each ratio with respect to the financial performance and condition of the Charter Company. a. Profitability: Return on average total assets (assume a 46% income tax rate) b. Turnover: i. Accounts receivable (based on average gross trade receivables). ii. Inventory (based on average total inventory). iii. Total assets (based on average total assets). c. Liquidity: i. Current ratio ii. Quick ratio d. Solvency i. Total liabilities to total equities ii. Total long-term debt to total long-term debt plus owners equity 2. The Charter Company had a number of nonrecurring and/or noncash components of income from continuing operations in 1983. Beginning with the 1983 earnings from continuing operations, adjust this figure for nonrecurring and/or noncash items (information for these adjustments are included in Exhibits 1, 3, and 4). 3. Calculate the cash provided by (used in) operations for each year during the period 1980-83, starting with the amount of working capital provided by operations shown in Exhibit 3 and adjusting for changes in current asset and current liability accounts on the balance sheet (Exhibit 2) which are related to operations. 4. Based on the information presented in the case, discuss the extent to which the stock market, in the aggregate, anticipated Charters problems and priced its common stock accordingly (see Exhibit 5). Comment on the extent to which operating current assets and operating current liabilities represented sources or uses of cash for the Charter Company for the years 1980-1983. comment on how the pattern of operating cash flows was similar (or dissimilar) to the operating cash flows for the 18 oil companies in Exhibit 6. Exhibit 1 The Charter Company Consolidated Statement of Earnings Years Ended December 31 (In thousands) 1983 Revenues 1982 1981 1980 1979 $5,656,7 70 $4,017,16 1 $4,966,17 1 $4,563,011 $4,296,370 117,958 43,402 14,080 661 2,357 $5,774,7 28 $4,060,56 3 $4,980,25 1 $4,563,672 $4,298,727 Equity in net earnings of Charter Security Life and other affiliates Expenses: Cost of sales and operating $5,364,8 20 $3,744,46 2 $4,512,21 5 $4,193,275 $3,624,619 Selling, general and administrative 99,987 101,968 190,656 112,694 154,608 Interest 80,886 69,879 89,196 77,133 44,000 37,939 36,074 32,511 35,085 28,851 49,428 - - - - 7,772 - - - - Total Expenses $5,640,8 32 $3,952,38 3 $4,824,57 8 $4,418,187 $3,852,078 Earnings before income taxes, etc. $133,896 $108,180 $155,673 $145,485 $446,649 83514 78350 99727 95248 78923 Earnings from continuing operations $50,382 $29,830 $55,946 $50,237 $367,726 Discontinued operations, net (1,950) 5,430 (48,229) - - - - - - (2,388) $48,432 $35,260 $7,717 $50,237 $365,338 5,463 - - - - $53,895 $35,260 $7,717 $50,237 $365,338 Depreciation, depletion and amortization Write-off of certain units at Bahamas refinery Write-down of tanker Income taxes Extraordinary charge Earnings before cumulative effect Cumulative effect on prior years of a change in accounting principle Net earnings Exhibit 2 The Charter Company Consolidated Balance Sheets 31-Dec (In thousands) Assets 1983 1982 1981 1980 1979 Current assets: $64,031 $59,939 $69,283 $94,112 $95,632 294,715 262,646 343,862 322,237 296,344 Other................................................ ....... 22,756 18,736 25,967 32,142 41,488 Affiliates........................................... ....... 31,030 30,106 11,479 16,312 499 2,868 24,744 8,815 3,133 8,745 351,369 336,232 390,123 373,824 347,076 receivables...................................... ...... 10,951 8,622 14,464 6,062 14,005 Net receivables...................................... .. 340,418 327,610 375,659 367,762 333,071 352,162 228,462 111,313 270,094 319,001 Cash & Cash Equivalents........................ Receivables: Trade accounts........................................ Short-term notes and current installments of long-term receivables............................ Less: Allowance for doubtful Inventories Petroleum........................................ ........ Other................................................ ....... 17,554 11,287 25,374 25,477 29,179 Total Inventories...................................... 369,716 239,749 136,687 295,571 348,180 Assets held for sale................................. 15,260 Prepaid expenses.................................... 12,302 14,578 27,316 16,217 16,971 801,727 641,876 608,945 773,662 793,854 311,151 374,913 389,060 407,402 408,635 affiliates........................................... ...... 261,115 125,955 76,751 83,190 55,060 Other................................................ ....... 4,237 41,515 41,160 39,990 44,342 Total Investments.................................... 576,503 542,383 506,971 530,582 508,037 Property, plant & equipment..................... 426,415 407,814 403,187 468,851 395,188 152,343 140,977 124,409 122,225 92,889 274,072 266,837 278,778 346,626 302,299 - 26,282 2,717 - - Total current assets................................. Investments Bahamas refinery affiliates....................... Charter Security Life & other Less: Accumulated depreciation and depletion..................... Net property, plant & equipment........................................ ..... Net assets of discontinued operations........................................ ..... Intangibles from acquisitions (net)........... 61,877 59,110 74,115 44,293 73,023 Other assets............................................ 99,020 91,558 69,800 51,097 51,481 Total assets............................................. $1,813,1 99 $1,628,0 46 $1,541,3 $1,746,260 26 $1,728,694 Exhibit 2 (cont.) Liabilities and Stockholders' Equity Current Liabilities: Notes payable.............................. ............ $144,00 0 $3,250 $50,500 $76,563 $858 Current installment of longterm debt....... 28,317 29,342 17,192 21,402 23,363 Accounts payable.............................. ...... 419,967 416,924 309,275 348,312 374,387 Payable to affiliates.............................. ..................... 39,143 21,257 - - - Accrued expenses............................ ........ 54,579 48,261 54,939 71,747 74,499 Income taxes.................................. ......... 14,749 21,625 27,217 17,433 28,208 Total current liabilities............................. . 700,755 540,659 459,123 535,457 501,315 111,134 133,086 251,425 404,631 416,087 Long-term debt excluding current installments........................ ....... Long-term debt payable to unconsol idatd, wholly owned subsidiaries............ 94,000 91,000 - - - 189,261 154,200 81,673 81,316 84,412 operations.......................... ................... 20,554 - - - - Deferred income taxes............................. 32,504 16,068 43,820 27,377 41,728 Deferred credits and other........................ 50,864 52,242 50,704 19,793 36,828 Preferred stock (a) ................................... 129,312 114,787 117,608 117,917 125,372 Common stock (b) ................................... 16,587 21,570 21,592 21,592 20,166 stock............................... ....................... 35,635 53,721 67,233 67,202 57,268 Retained earnings............................. ....... 429,298 448,924 447,555 470,476 449,629 3,295 1,789 593 499 (4,111) 614,127 640,791 654,581 677,686 648,324 1,813,19 9 1,628,04 6 1,541,32 6 1,746,260 1,728,694 Subordinated debt, net of discount, excluding current installments................ Net liabilities of discontinued Stockholders' equity Additional paid-in-capital on common Net unrealized gain on investment securities of unconsolidated sub sidiaries, net of taxes............................. Total liabilities & stockholders' equity....... The Charter Company Exhibit 3 Schedules of Working Capital Provided by Operations Years Ended December 31 (In thousands) Working capital provided by operations $50,382 $29,830 $55,946 $50,237 $367,726 37,939 36,074 32,511 35,085 28,851 Joe Paper (17,125) Company............................ .. - - - - 7,850 (7,631) 4,254 1,928 4,843 and other (117,958 affiliates.............................. ) .. (43,402) (14,080) (661) (2,357) 12,511 18,542 27,548 16,775 10,376 49,428 - - - - Earnings from continuing operations.... Charges (credits) to earnings affecting working capital: Depreciation, depletion, and amortization....................... ................... Gain on exchange of investment in St. Deferred income taxes and other............. Equity in net earnings of Charter Life Equity in net losses of Bahamas refinery affiliates included in cost of sales........... Write-off of certain units in Bahamas refinery............................... ................... Write-down of tanker............................... 7,772 - - - - $103,364 $409,439 Total working capital provided by operations.......................... ................... $30,799 $33,413 $106,179 Exhibit 4 THE CHARTER COMPANY Selected Notes of 1983 Financial Statements 1. Significant Accounting Policies and Other A. Basis of Financial Presentation . The accompanying consolidated financial statements include the accounts of The Charter Company and its majority-owned subsidiaries ("Charter") other than Charter Security Life Insurance Company (Louisiana) and subsidiaries ("Charter Security LIFE"), COFI Credit Corporation ("COFI") and First Charter Savings Bank ("First Charter") which are accounted for by the equity method. Charter's Bahamas refinery affiliates and other affiliated companies, all 31% to 50% owned, are also accounted for by the equity method. All significant intercompany accounts and transactions for Charter have been eliminated in consolidation. B. Inventories. Inventories are stated at the lower of cost or market. Certain petroleum inventories aggregating $115,242,000 at December 31, 1983 and $83,664,000 at December 31, 1982 were determined under the last-in, first-out method ("LIFO"). Such petroleum inventories, if stated at current costs, would have been $41,554,000 and $48,051,000 higher, respectively. If the first-in, first-out method ("FIFO") of inventory valuation had been used for such inventories, reported net earnings would have been lower by $6,497,000 ($a.28 primary and fully diluted earnings per share) for 1983., $6,015,000 ($.21 primary and fully diluted earnings per share) for 1982 and $12,750,000 ($.45 primary and fully diluted earnings per share) for 1981. The cost of the remaining petroleum and other inventories is determined under the FIFO method. Crude oil and product exchange balances are reflected in petroleum inventories. Certain petroleum inventories at December 31, 1983 were less than inventory levels at December 31, 1982 or the date of acquisition resulting in a liquidation of LIFO layers which were carried at lower costs. If such inventories had replaced at current costs, net earnings for 1983 would have been lower by approximately $12,803,000 ($.56 primary and fully diluted earnings per share). Certain petroleum inventories at December 31, 1981 were less than prior year levels resulting in a liquidation of prior years' LIFO layers which were carried at lower costs. If such inventories had been replaced at current costs, net earnings for 1981 would have been lower by approximately $15,686,000 ($.56 primary and fully diluted earnings per share). F. Change in Accounting Principle. Effective January 1, 1983, Charter changed its accounting method of expensing the cost of spare parts at the Houston refinery to inventorying the spare parts and changing the cost to operations as utilized. This change was made to improve the matching of costs of spare parts to the benefits derived from their usage and establish financial control over these items. Net earnings for the first quarter of 1983 have been restated by $5,463,000 to reflect the cumulative effect of the change on prior years. The effect of this change was not material to 1983 earnings from continuing operations. The pro forma and cumulative effects on net earnings of prior years is not determinable because the necessary data is unavailable. G. Miscellaneous Policies. Refining, marketing and other facilities are depreciated principally by the straight-line method over their estimated useful lives.During 1983, Charter revised the estimated useful lives of certain property, plant and equipment. The effect of this change in accounting estimate was an increase in net earnings of $3,003,000 ($.13 primary and fully diluted earnings per share). During the fourth quarter of 1983, Charter renegotiated a contract and recorded a gain of $33,600,000. 5. Investment in Bahamas Refinery Affiliates Charter's investment in the Bahamas refinery affiliated includes three 50% owned joint ventures: Bahamas Oil Refining Company ("BORCO"), BORCO Desulfurization Company ("BODCO") and BORCO Marine Company ("MARCO"). These joint ventures receive fees from the partners for use of the refinery and related facilities. The operations of these joint ventures do not reflect the partners' purchases of crude oil, sales of refined products and processing or storage agreements with third parties. Charter's share of the net operating losses of these ventures was $12,511,000, $18,542,000 and $27,548,000, for 1983, 1982 and 1981, respectively, including depreciation and amortization related to the excess of the appraised value over the historical cost of the assets allocated to property, plant and equipment at the time of the acquisition. charter's share of the losses of these ventures is recorded as cost of sales and operating expenses in its consolidated statements of earnings because these joint ventures are part of Charter's crude oil refining system. In addition, BARCO and BODCO wrote-off certain units during 1983 since use of such units is not anticipated in the foreseeable future. Charter's share of the write-off plus the write-off of the related excess of the appraised value over the historical cost of these asses was $49,428,000. Exhibit 5 The Charter Company Quarterly Earnings per Share, Cash Dividends, and Common Stock Price For the Fiscal Year 1983 and the First Two Quarters of 1984 1983 First Seco nd 1984 Third Quarte Quart Quarte r er r Fourth First Second Quarter Quart er Quarter Fully diluted earnings per share: From continuing operations..................... $(0.31) $0.51 $1.34 $0.23 $(1.49 ) $(2.84) Net earnings.......................... .................. (0.05) 0.43 1.34 0.23 (2.38) (35.14) 0.25 0.25 0.25 0.25 0.25 - High 13.375 13.750 12.500 12.250 12.875 9.750 Low 11.125 10.750 10.250 8.000 8.500 2.000 Common dividend per share.................... Market price